And Now, A Present: "Are The Brokers Broken?" - A Reprise

Often times we are asked "why does Zero Hedge prefer to provide information in piecemeal increments and isolated snapshots (of irregularity) rather than write comprehensive articles (or even a book) that explain, from beginning to end why everything is broken - the end?" There are two answers - a short and a long one. The short answer is that finance, more so than any other field, changes so rapidly that the nuances are always and constantly on the margin, which in turn is stable only for the period of time that it is observed, and then it becomes part of "technical analysis." (Indeed, the Schrodinger wave function collapse is just as alive and well in finance as it is in the quantum arena). As such, we adhere to the paradigm describing the distinction between giving a man a fish and teaching a man to fish: we believe that it is far more useful to demonstrate all that ways in which the market (and global economy) works, or rather doesn't, than engage in extended exercises of vanity, which serve as much to stroke the author's ego, and demonstrate one's knowledge of SAT words, as they do to elucidate the matter at hand. By sharing our own views of events as they transpire in real time, be they right or wrong, we hope to provide our readers with the "connect the dots" patchwork required to evaluate relevant financial events as they occur in real time, instead of describing them in the in vitro vacuum of moody brooding. (As for a book, we are more than confident enough "independent" bloggers out there will succumb to the very system their protest against, and pen a few hundred pages on the goal-seeked topic of their choosing - the last thing the vast upcoming book pyre needs is our own intellectual self-pleasuring). The long answer is far longer, and, ironically, deserves a post of its own. But this is neither the time nor the place. What then is the purpose of this post is to break away from our tradition, but also not to recreate the wheel, as many others find delight in doing. Instead, as a special present to our readers, we share the seminal analysis by Citigroup's Matt King from September 5, 2008, titled "Are The Brokers Broken?" which in one place explains, better than anyone else has ever done, why the system is terminally broken, and why the best anyone can hope for is to keep kicking the can down the road until it all comes crashing down.

The report, which came out ten days before the Lehman collapse, was according to some, one the primary catalysts for the collapse of Lehman and the subsequent near collapse of the entire house of cards, as it explained better than anything to that point (and arguably since), just how hollow and broken the one all important component of modern finance - the multi-trillion shadow banking system is.

Sure enough, once the majority of analysts and traders out there, who for the most part are simple automatons who only push buttons all day and can barely see beyond the 8th screen on their Bloomberg terminal, comprehended the irreparable nature of the systemic break in terms even they would understand, the panic commenced, and resulted in a full blown run on every form of liquidity which also happens to be synonymous with quote unquote bank: yes, Lehman, on the simple visible side, but far more importantly, on money markets, that primary conduit (along with repos) of the shadow banking system. It was this, far more than the Lehman collapse (whose end they had greenlighted), that stunned the powers that be, who did not anticipate any of the aftershocks that would start cascading through the US shadow banking system which according to our estimates is about $15 trillion most recently (well above total traditional liabilities which are still below $14 trillion) , while according to others when one adds the rehypothecation "value" of various commingled assets, could be up to $4-6 trillion larger.

So while we all partake in the spirit of goodwill to man and festive joy (however brief), if for no other reason than because "we should", our present to our readers is that most important gift - knowledge, and the understanding of the truth behind the headlines which the traditional media will never provide, for fear of the all out panic that would ensue if the general public, just like the specialized financial industry, in the days after September 5, 2008, were to understand just how futile the actions of the Fed and the global banking cartel are when presented with all the facts.

In summary: the following report was 100% correct when it first came out and predicted the Lehman, and all other collapses; it is even more correct now, as nothing has changed, only the stakes have now gotten that much ('infinitely' some would say since every central bank is now all in on preserving the fake reality that is artificial central planning) greater. Unfortunately, because nobody listened and nobody learned from the events in late 2008, the next time around there will be no redo.

This is what I find interesting about news reportage and analysis in general.

It now seems to be common knowledge that AIG and MFG both failed due to excessive leverage, specifically in their London units where it is apparently legal to hypothecate the same collateral a hundred or more times over, to different parties. Or so MAx Kieser and Stacy told me.

What the heck is the point in any of these long winded discussions and papers and arguements?

There is a fractional collateralization scam being played out in London. Kill that loophole perhaps? First? That is huge. It has caused two humongous, system threatening shocks.

Wierd, our brokers over here are the ones buying us a friday lunch of wahtever we want (ordered in, of course) week in week out, just so that the next time someones looking for a fill on xy equity or credit product, we do it through Tullett as opposed to BGC as opposed to Cantor as opposed to THE LIST GOES ON. These brokers have nermous lawsuits against each other already, just because they try and win clients back since a lunch doesnt exactly keep a trader satisfied for long...

So no, i dont actually think brokers are buying Ferraris by the truckload.

You're not living in one of the countries to which inflation is "exported", hmm?

How about - 33% foodstuffs price inflation in one year? VERY REASONABLE? WTF? Technically, this is something in-between "typical fiat rip-off inlation" and "hyperinflation" (and together with static wages, in-between business as usual, and hyper-stagflation).

When does stuff stop being "very reasonable" to you - when it goes BOOM!?!?

The point of these 'long winded discussions', is that they are exceptionally helpful for those of us who are interested in the actual inner-workings of shadow banking. The hyper re-hypothecation scam has been a revelation into the horribly flawed logic with which this cotton candy 'financial innovation' fiasco.

Since much of the resources have now been fully backed into the financial sector in London, the rest of the UK has been marginalized as has been evident for the past thirty years or so. Cameron has to stand behind the collapsing banking oligarchs no matter what. Good-bye UK.

I feel you ORI. After replying angrily to a poster about his demands of proof of manipulation of the PMs markets and you replied to my post offering empathy over my frustrations, it got me thinking about the anger in my reply and it made me realize that some of us have known or understood "The Game" for some time. What I have to remember is that the awakening has only just started and that there are literally billions of folk who don't have the message yet. It will be a long road and I just have to put aside my frustrations and hope that articles like this get the attention of one more sheep.

Are the brokers broke? The global reply to that is; if the world's monetary system is predicated on credit or debt or promises to settle accounts, rehypothecated promises, leveraged promises, and that account was opened on credit, and the credit was accepted without the means to settle (just like the $US since 1971), then the account holder is bankrupt from the start. How will the entire world settle a promise that has nothing backing the promise? It literally can't and we were warned by many.

It is obvious that the system is a sham but you can only see the sham if you accept the system as it really is and not how it has been portrayed. That takes a quantum leap.

Are the brokers broke? The global reply to that is; if the world's monetary system is predicated on credit or debt or promises to settle accounts, rehypothecated promises, leveraged promises, and that account was opened on credit, and the credit was accepted without the means to settle (just like the $US since 1971), then the account holder is bankrupt from the start. How will the entire world settle a promise that has nothing backing the promise? It literally can't and we were warned by many.

This is my first exposure to this article. I must say, the language within would have been indiscernible to me just a few months ago. Reading ZH among others is a means for laypersons like me to educate ourselves.

I'm truly grateful for the re-run. It also helps to remind me that even within these corporations there are good people willing to call it like they see it.

I suppose that is what Tyler(s) is/are to begin with.

As grateful as I am for this site, part of me wants to take the blue pill.

There's limits on how many times you can rehypothecate something in the U.S. - the difference is in London you can do it virtually an unlimited number of times.

Rehypothecation is not "necessarily" a bad thing as its used in finance all the time to provide things like leverage accounts (you deposit $1000, but get to play with $3000). But there has to be a limit on this, and unlimited rehypothecation is an obvious and clear problem, especially when it comes to physical assets used as collateral by multiple parties.

For example your house is used as collateral by YOU, and then rehypothecated by the bank since it's on their balance sheet as "possibly" being theirs, so they use it as collateral as well. This is where it all starts becoming a cluster fuck as there's only a limited number of physical assets, but 10 "potential" claimaints to that asset.

Yup, WALMART does have a great future ....... in other countries. I'm deliberately avoiding WALMART like the plague. It's obvious they don't need my money; after all, CHINA awaits. This country has been WALMARTIZED . Let someone else support that company ...... i'm out. what little i have left goes straight into local business or physical metal & foodstuffs.

You nailed it, Lynnybee. Let me advise that people begin now to develop those relationships with local retailers. When TSHTF they might be highly selective with whom the choose to do busniess. It would be most wise for you to be one of them. The future of economies is not global, it's local and way smaller than you can guess.

Each $ spent at a big box store yeilds about $2 in economic activity for the community. Each $ that "goes local" (ie - is recirculated as local purchases for local goods and services yeilds $7 in economic activity for the community.

By doing repeated, habitual bargain hunting at places like Walmart we have been spending ourselves poor.

We need to understand how we have, by our minor, daily purchasing habits, ruined this country...

...and then change that mind set and rebuild our communities.

Each of us can do that, now. We must in order to win back our economic freedom.

It's a comforting thought to know though that the big international US companies are getting screwed right now with their money earned overseas sitting there in Euros. They desperately want it back here tax-free, of course, which ain't happening so far even though Jeff Imelt suddenly became Obama's BFF.

Maybe thats why the Dollar Stores are becoming more popular (I don't shop at them or own shares). This only shifts the cause of the problem from Wal-Mart to a different source, local businesses are still screwed.

I hope that the public is educated to the point that they understand the crime of debt-based money, that the whole thing collapses literally overnight, and then a lightning-fast reform is implemented, with a functioning, constructive system put in place.

Spot on Tyler. The underground world of intelligence thanks you for your contributions and continued awesomeness. Thank you also for the foresight to remain annoymous and focus on "connecting the dots". Rock on through 2012 ZeroHedge!

'As for a book, we are more than confident enough "independent" bloggers out there will succumb to the very system their protest against, and pen a few hundred pages on the goal-seeked topic of their choosing - the last thing the vast upcoming book pyre needs is our own intellectual self-pleasuring'

Whatever an ad blocker is I'm fairly certain I don't have it. Thank you ZH for the opportunity to learn that which I have never been exposed to. It's been a long struggle, but I am determined to gain a vague understanding of the financial system. God bless

That was meant as sarc, but I'm going to ask every shop owner I deal with if they'll accept credit when I pay for items in cash, just as an experiment. If they don't accept credit, how will I pay them?

As an example of how truly f*cked up this whole thing is - the Administration refuses to prosecute criminal wrongdoing for the fear that if the public knew what was going on, they would stop investing:

I haven't read this yet, but before I do I want to say that though I would enjoy the feeling of vindication seeing "the system"* collapse so that the world could get back to "normal"**, in the past few weeks*** I've come to believe that can-kicking may be the best we can hope for.

Thank you in advance for this article, no matter what it says. Your intro makes it seem an apprpriate and timely Christmas present and no matter how furious and sick makes me, I'll enjoy knowing whatever information it offers.

Thanks zerohedge; love all of you to pieces who toil and comment here. Really. If it weren't for the information I find here and the emotional release it gives me to scream and spit at my computer screen, I'd probably have done something crazy by now and be in jail. I appreciate all articles and all comments; they are a lifeline to a semblance of sanity.

*the bankster/wall street heist system

**is there a normal? was there ever a normal? will there ever again be a normal? (Please don't remind me that chaos is normal -- I know that but I think that means universal chaos, like the universe itself, not the bankster/wall street heist kind. The latter is what I'm asking about ever being "normal" again. Like with Glass-Steagall back in place.)

***watching the EU-carnival racket games, and then MF Global, then the Fed audit info, and then Bernank finally bankrupting the US for BOE; and then rehypothecation and its implications, and then the ongoing swindle we call "elections"... I'm getting ulcers.

That’s what Sandra Baker, of Harrodsburg, Ky., said she thought when she walked down a hall toward a big green bag, with a teacher’s aide sitting beside it, at her son’s school, on Dec. 14.

“Mama, is that you?” a voice coming from the bag said.

Here's what the school said:

“The employees of the Mercer County Public Schools are qualified professionals who treat students with respect and dignity while providing a safe and nurturing learning environment,” Davis said in the statement.

Artalejo's daughter, Brittany Bilson, told the television station that her mother's teeth were chattering and she was moaning and shaking. Bilson said the nurses told her mother to shut up, taped her mouth closed and joked they would be fired if they were caught.

Here's what the hospital said:

"But as a hospital we are fully committed to providing quality and compassionate care. The allegations that were brought forth were completely against that commitment."

"making a killing in the market: shoot your broker." that's the coffee mug from a guy who was on the sell side for 20 years. I don't think the broker side is going anywhere with cloud computing, nat gas and solar power still readying themselves to completely change the way we live our lives. The buy side (the banks) have been bailed out for these technologies to be brought to bear by the private marketplace. Whatever the result on the War on Terror (which is the bulk of Federal Spending and the reason for the massive size of the USA's debt and deficit) the ability to make money beyond the dreams of avarice is alive and well. Love the sentiment presented here of course.

"Although we at the Federal Reserve remain focused on addressing the current risks to economic and financial stability, we have also begun thinking about the lessons for the future. I have discussed today two strategies for reducing systemic risk: strengthening the financial infrastructure, broadly construed, and increasing the systemwide focus of financial regulation and supervision. Work on the financial infrastructure is already well under way, and I expect further progress as the public and private sectors cooperate to address common concerns. The adoption of a regulatory and supervisory approach with a heavier macroprudential focus has a strong rationale, but we should be careful about over-promising, as we are still rather far from having the capacity to implement such an approach in a thoroughgoing way. The Federal Reserve will continue to work with the Congress, other regulators, and the private sector to explore this and other strategies to increase financial stability."

Spoken like a true over-Ivory-Towered academic. I'd like to introduce him to the unseen side of my woodshed and get him some dirt under his fingernails, holes in his breeches, and calouses on his hands--before I kick the ever-lovin' cr*p out of him and send him back home to hide under mommy's skirt.

Why we love you. Maybe it is truth that is the ultimate commodity? Humans are so utterly starved of truth. We waste our precious little bit of time in a sea of lies and know that bullshit is rape. We deserve a better place to begin from.

We are HUNGRY. It's a good and proper hunger though. People in general are good. People in charge are bad. All we really ask is that we be left alone to experience our journey free of your perverted itinery. We don't want to rule the world, YOU DO.

We don't propose to control you, You propose to control us.

We say politely, NO.

We will not always be polite, it is our preference to be polite, it is our nature to be polite.

The scientific method makes a mockery of any of the accepted practices in above paper. It sounds like fraud in the inducement is known to every party before the fact, and all conspire with this knowledge. I am really shaken there are so many people that do this for a living when it really just accelerates our all dying. I hope one day we abandon all this crap and people that demonstrate sociopathic tendencies are prevented from doing that which they desire. What a small price to pay, considering.

Ensuring that all your accounts are cash rather than margin is a start but after MF Global even that isn't enough.

Brokers have reason to fear this, as it threatens the major source of their incomes, and will reduce trading to boot. They can't let you buy 5000 shares for $7.95 or whatever without being able to generate substantial income from their possession of the assets in street name.

My old muni bearer bond certificates were beautiful and I miss them.

I've asked for years to be able to hold my California GO bonds directly with the State of California (as at http://www.treasurydirect.gov ) so I hold them with a custodian in a segregated trust accoun for 30bps per year. There must be some reason why refuse, probably there is some benefit to brokers to possess these securities in book form.

good memories.. those of you who wants to find out why people were heavily short LEH's and bunch others, but especially LEH, they will find the answer in the form of a "matchbook" withdrawal/drop graph in this very paper, was an excellent resource then, and it still is.

Interesting article but the concerns no longer apply. Fast forward to today's reality. The regulators and the regulated are now co-conspiritors in a fraud to hide or bail out any insolvency or illiquidity. The Banker and Broker now has no risk that is not impicitly backstopped by a central banker stealing from the collective wealth of the nation by money printing. MF Global was a brain fart by the regulator who pushed a small button on MF without realizing it was connected to a nuclear device. I'm sure they have been ordered never to push that button again and to watch more internet porn.

Paragraph 15 of the accounting rule FAS 140stipulates that the amount referred to on the balance sheet statement need only be“collateral pledged to counterparties which can be repledged to other counterparties”.

Nothing is 'broken' or 'dysfunctional'. Not more than it was during many other periods over the last 200 years anyways. Things are always in disarray. Marekts are always going up and down. Hundreds of banks and brokers have gone bankrupt over the last 200 years.

What we're whitnessing - in terms of historic significance - is just another random year in financial history.

Let's leave out of this discussion the custody banks ... where $40 trillion resides (mostly in the form of assets other than currency) looking for trouble and finding some. What is explained by Citi is that costs of managing that sum were greater than the sum, itself. Discussion of this is for another day.

Let's look at the big picture where the entire economy is broke yet the obsession du jour is malfunction of the dealers (in that they cannot provide enough liquidity to support transactions on their own accounts and so must make use of funds entrusted to them by clients). Fair enough, but this is not unlike a person with a house engulfed with fire obsessing about a leaking water heater in the basement.

Broker/dealer illiquidity CONTRIBUTED (along with broker/dealer malfeasanse) to a failure that was inevitable due to the excess cost structure of the economy as a whole. If the broker/dealers had not failed some other link in the chain of finance OR IN SO-CALLED PRODUCTIVE ECONOMY would have broken as indeed it did. What failed at the bottom was -- and is -- the non-productive energy waste infrastructure. This failure is ongoing, taking place first in the US and is now underway in other countries (Ireland, Spain, now Canada, Australia, Dubai and China).

I realize that "central planning" is the new boogieman around here, but I really object to the attempt to describe the shadow banking system - the exact, complete and total opposite of "central planning" - as having anything to do with "central planning".

How about objecting to what is actually being said: that central planning is doing everything it can (not enough) to prevent the inevitable unwind of shadow banking via an endless series of QEs where the unregulated credit money is onboarded on the government's balance sheet, for the simple reason that shadow banking only works in an environment that is confident in its own self-sustainability, and not being on central bank life support.

Shadow banking has plenty of confidence. Their ultimate backstop is now the entire cumulative wealth of the nation via the FED. What better counterparty could you want?? Every QE is another stealth theft of cumulative wealth funneled to the bankers. The resolution of the 2008 crisis was an effective merger of government and the bankers. Central banks are doing way more than life support for the banks. We are early in the game. There is a lot more accumulated wealth for the FED to steal.

so the big security lenders like STATE STREET etc dont think making a percentage both ways selling govt bonds at an interest rate charge and buy collateral at an interest charge is worth it....... I think a new paradigm maybe well on its way. I read recently that the g-uber-mint may force pension funds hedge funds etc to keep 10 percent of their asses in gov't bonds.

after reading that i would assume their has been an increase in lending out govt bonds and buying relatilvely more safe corporate bonds. new paradigm?

ZH offers inputs,unconnected dots of the world.By observing and going deeper into the direction in which those dots points we can have a better and more comprehensive understanding of how the financial / economical machine works and what we may expect from it.We learn not to be taken by surprise by the unfolding of events and rather be almost prepared fotr them.Or better even, to use the machine for our own advantage.

Speaking the truth about how the central bankers are handling our economy is now a crime. The truth can no longer be spoken in polite company because we're all supposed to pretend that all is well, otherwise, it will set off the herd. Those that seek the truth to prepare are a national security threat.

Keep on keepin' on Tyler. It would be so easy for you to write "the book" as we know you could so easily do. But please don't. The education I, for one, am getting here is invaluable. We all know how the book ends already....

my question to everyone: does anyone have a copy of the cited paper "Where Should Hedge Funds Keep Their Cash?" (September 2008)? I've googled around a bit and didn't have any luck finding a copy; the author cites it a couple of times, and I'd like to read it.